Your Tax-Cheating Spouse May Cost You

Bischoff: What to do when you suspect a spouse or ex of tax misdeeds.

By

BillBischoff

Before you file a joint Form 1040 for 2011, know this: under the principle of joint and several liability, you and your spouse will both be on the hook for up to 100% of any federal income tax underpayment for the year. It generally doesn't matter which spouse is responsible for the underpayment. This is true even after divorce. In other words, if your spouse fails to declare income and/or fails to pay tax bills for years when you were married and filing jointly, the IRS can go after you to collect the entire unpaid balance (plus any interest and penalties) even though you've since become divorced. Worse yet, the joint and several liability rule remains in force even if your divorce decree states that your ex is responsible for any unpaid taxes from your joint-filing years. The IRS is not bound by that agreement, and the Feds will just go after whichever person appears to be the easiest to collect from. Thankfully, there are a several ways to avoid this dire outcome.

File Separate Returns

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If you suspect your spouse is ethically challenged when it comes to taxes, please consider filing a separate return for 2011 using married filing separate (MFS) status. Your spouse will then have to use MFS status too. With this procedure, you're only responsible for any unpaid taxes on taxable income that was, or should have been, reported on your separate return. As long as you play by the rules, you spouse's tax misdeeds won't directly affect you. While using MFS status may result in a bigger combined tax bill for you and your spouse than if you file jointly, consider the extra cost the price of insurance.

Note: For more details on MFS status (including situations when it can actually lower your tax bill instead of raise it), see Married but Filing Separately.

Request Innocent Spouse Relief

The so-called innocent spouse rule is intended to help eligible joint-filing spouses from being held responsible for their not-so-innocent spouses' tax understatements. You must show that when you signed the erroneous joint return in question, you did not know and had no reason to know there was a tax understatement, and that it would be unfair to hold you responsible for the understated tax. For example, the innocent spouse rule would be available if your ex concealed income from you, failed to report that income on your joint Form 1040, and you did not benefit from that income.

You apply for innocent spouse relief by filing Form 8857 (Request for Innocent Spouse Relief) with the IRS as soon as you become aware of a federal income tax liability that you believe should only be the responsibility of your spouse or ex-spouse due to the innocent spouse rule. In most cases, you must file Form 8857 no later than two years after the first IRS attempt to collect unpaid taxes from you.

Request Equitable Relief

The so-called equitable relief rule is intended to help eligible joint-filing spouses from being unfairly held responsible for underpaid federal income tax on reported income. To clarify, the equitable relief rule is potentially available when income was properly reported on the joint return, but the full tax bill was not paid. (For relief from taxes on unreported income, you must rely on the innocent spouse rule.)

For example, the equitable relief rule would be available if you and your ex filed a joint return that properly reported all your income and deductions, you gave your ex the money to pay the tax bill, but he spent it on a secret trip to Vegas while claiming he used it to pay the Feds.

You apply for equitable relief by filing the aforementioned Form 8857 with the IRS when you believe that an unpaid federal income tax bill should be the responsibility of your spouse or ex-spouse due to the equitable relief rule.

The Bottom Line

While the innocent spouse and equitable relief rules are well-intentioned, they have some serious shortcomings.

* After you file Form 8857, the IRS must notify your spouse or ex-spouse that you are seeking innocent spouse or equitable relief. There are no exceptions to this rule, even if you are a victim of spousal abuse.

* The IRS must also notify your spouse or ex of the outcome of your request for innocent spouse or equitable relief. If your request is approved, your spouse or ex will no doubt figure out that the IRS will now be seeking to collect from him or her instead of from you.

* Filling out Form 8857 is tricky (you may need professional assistance), and the granting of innocent spouse or equitable relief depends on the whims of IRS personnel.

For all these reasons, I think it's a much better idea to simply use married filing separate status when you have doubts about what will happen if you file jointly. Filing a separate return is in the nature of prevention. Relying on the innocent spouse rule or the equitable relief rule is in the nature of after-the-fact damage control. Prevention is always better than damage control. Please keep that in mind when deciding whether you should file jointly for 2011 or file separately.

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